Week in Review – January 26, 2014

What a Surprise.
Barely a week ago as the earnings season was about to begin it seemed perplexing that there was talk of seeing a 6% increase in comparable earnings. Based on retail earnings and performance from my personal barometers, Grainger (GWW) and Fastenal (FAST), there didn’t seem to be much adding to the integrity of the foundation.
As with the two previous earnings seasons the financials leading off the reporting season had reasons to be proud but there was little glory to be trickled down. It probably takes more than a growing Netflix (NFLX) subscription base to create optimism among traders, although there were some who were eager to use that news as being a sign of an improving economy, apparently believing that the first thing a newly employed individual does is to activate a Netflix subscription.
However, even with some favorable earnings reports to end the week the constellation of news coming from the rest of the world, including Chinese production disappointments, Turkey’s monetary woes and Argentinean debt had to come as a surprise as the DJIA fell over 300 points, never even making a feeble attempt to stem the flow of losses.
What we discovered about ourselves is that we much prefer the false security offered by believing that Chinese economic reports are accurate than their actual accuracy. Report after report that has final results perfectly aligned with projections should have been an early clue that perhaps the books are occasionally cooked. But as long as they supported a thesis of a growing worldwide economy there was reason to be optimistic.
That changed this week, and somehow we were surprised. What will be the ultimate question as the coming week begins is whether those new prices represent values or value traps.
Just a few days ago there was every reason to believe that the current market was beginning to settle into an historical mode, when earnings actually mattered and were what moved markets. With questions regarding tapering largely thought to have been resolved and with the worldwide economy, currencies and debt markets being reasonably calm, it seemed as if fundamentals would be back in vogue.
Never get too comfortable or believe what you are seeing. Increasingly, it feels as if everything that you believe to be the case should be considered as being on par with Chinese economic reports.
This week offers challenges that weren’t present last week. For the second consecutive week I had fewer positions assigned than I had anticipated and have less in cash reserves to take advantage of lowered prices than I would have liked.
However, I’m not anxious to go on a buying spree quite yet and will likely wait for some sign of stabilization in the overall market, rather than attempting to thread a needle with trades in the mistaken belief that outliers can be found in what may be a developing vortex.
As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum and “PEE” categories this week (see details).
Among companies beating analyst’s expectations and not having done so through the optics of share buybacks were Baxter International (BAX) and Bristol Myers Squibb (BMY). Both were included in Friday’s down draft and both appear to have been impacted out of proportion to their historical volatility. While that doesn’t preclude further journeys lower it does give me some basis for believing that new positions may be better suited to outperform the S&P 500 going forward. Both offer expanded options, thereby creating greater opportunities to diversify risk on the basis of time.
A frequent candidate for share ownership is Coach. It fell, as so often has happened over the past 18 months after its earnings report last week. That shouldn’t have been too great of a surprise. What is a surprise, however, is that despite universal condemnation, it has been incredibly resilient. I sold puts last week after earnings that subsequently expired and now believe that shares, if not bridled by a lower moving market, are going to stay at this level or move higher. As a covered option position either of those are perfectly acceptable outcomes and Coach has proven itself to be more than an acceptable covered option holding ever since it has fallen out of favor.
While retail has been an abysmal place to park money, it’s hard to not finally consider shares of Kohls (KSS). In the past I would typically only consider shares in advance of the dividend and was reluctant to do so otherwise, because Kohls only offered monthly options. However, it has now joined the growing number of expanded option stocks and has many more strike levels available than before, thereby offering greater flexibility in designing exit strategies. It’s shares have fallen over 12% in the past two weeks, reportedly due to concerns over weather related sales decreases.
Fastenal , which I often look toward as a measure of how well economic growth is trickling down to smaller value added components reported earnings recently. Since they had previously guided lower the results shouldn’t have been too surprising, yet they were. It didn’t take long for shares to recover from earnings. However, with Grainger reporting its own disappointments Fastenal felt the fury. With its ex-dividend date this coming week I see it as an opportunity to add shares at what has been a safe level. Despite a somewhat higher beta, it, too appears to have been disproportionately victim of the market decline and that may offer some relative immunity in coming days.
MetLife (MET) is one of those companies, as with most financials, that should benefit from a rising interest rate environment. Like others in the sector it fell mightily on Friday and is getting to a point of again being interesting. Like many other stocks this very recent fall brings them closer to appealing prices. In this case I would prefer getting even closer to the $48 level. However, I am considering a longer term option contract, such as the March 22, 2014, which would encompass both an ex-dividend date and earnings, which take place between now and February 12, 2014 and provide some time for share recovery in the event of an adverse reaction to the report.
International Paper (IP) is similar to MetLife insofar as its share price has come down to a more realistic level and that it will be going ex-dividend and reporting earnings during the February 2014 option cycle. Recently, shares appear to have been trading in a 4 month cycle from low to low and we are approaching that 4 month period again, just as shares are also heading toward its lows. As with many stocks this coming week there is heightened concern that they will break below support levels and International Paper is among that group. It’s attractive dividend, and again, similar to MetLife, the use of a longer term option may provide a nice combination of dividends, option income and price protection during a period that the market may be at risk to under-perform.
Texas Instruments (TXN) reported earnings earlier last week that were in-line with estimates. That alone was reason to reward shares, as the bar may be set increasingly lower. It didn’t fare terribly during the market meltdown and that may be its theme during any upcoming market weakness. Shares go ex-dividend this week and still offer a option premium that warrants attention in light of its low beta.
The coming week is a busy one for earnings. A more detailed look at this week’s earnings considerations provides some of the criteria used in filtering companies from one another. Of a number prospects that I screened for this week the two that stand out as opportunities by virtue of meeting my criteria (give link) are Facebook (FB) and Seagate Technology (STX).
Seagate Technology, rather than becoming a dinosaur, has had been envisioned in the post-PC world has been thriving, as has its share price. Its trajectory higher is alone cause for concern, whether at earnings, during a market decline or at any other time. The options market is implying a 6.5% price movement, which would envision a lower price strike of $55. Meanwhile, a 1% ROI can be potentially obtained at the $54.5 level. That’s not a terribly wide margin of safety, so any potential seller of puts should be prepared for the possibility of assignment.
Finally, as Facebook prepares to report earnings, its scant history of doing so has been a story of monetization of the mobile interface and in general the story has been continued surprise of how well they have been able to develop that revenue source. The options market appears to be expect significant price movement upon earnings, as the implied volatility is 11%, taking shares as low as $48.50. However, a 1% ROI can potentially be obtained at a strike level as low as $47 for those with some adventure in their character. Facebook’s more rationale price trajectory and occasional pauses may however make it a less adventurous earnings related trade than compared to Seagate Technology
Traditional Stocks: Baxter International, Bristol Myers Squibb, International Paper, Kohls, MetLife
Momentum Stocks: Coach
Double Dip Dividend: Fastenal (ex-div 1/29), Texas Instruments (ex-div 1/29)
Premiums Enhanced by Earnings: Facebook (1/29 PM), Seagate Technology (1/27 PM)
Remember, these are just guidelines for the coming week. The above selections may become actionable, most often coupling a share purchase with call option sales or the sale of covered put contracts, in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week with reduction of trading risk.